Redefining Intellectual Property Value* The Case of China ©2005 Copyright PricewaterhouseCoopers. All Rights Reserved. Rights All PricewaterhouseCoopers. Copyright ©2005 A Technology Center Publication Acknowledgements TECHNOLOGY CENTER Managing Director Bo Parker Managing Editor Christine Wendin Analysts Chris Cooper, Ken DeWoskin, David Hoffman, Alan Morrison Contributor Mark Palim Associate Editor Saba Mirza Production Manager Bruce L. Leininger Cover John Goldie Research Susan Mills, Peter Vigil Advisory Review Board Frank Brown, James Flanagan, Mark Haller Reviewers Andrew Binstock, Soo Earn Keoy, Ed Pausa, Joanne Oswin, Silas Yang, Allan Zhang Special Thanks For assistance during the preparation of this report, we wish to thank Phil Barnett, Linda Kates, Vincent Torres, Ashley Yuan INDUSTRY PERSPECTIVES During preparation of this report, we benefited from interviewing the following executives: H. Raymond Bingham, Executive Chairman, retired; Cadence Design Systems Bradley Botsch, Chief Patent Counsel; ON Semiconductor Dan DiMase, President; SemiXchange Warren Heit, Partner; White & Case Larry Horn, Vice President, Licensing and Business Development; MPEG LA William Lash, former Assistant Secretary for Market Access and Compliance; US Department of Commerce Lucy Nichols, Global Director, IPR Brand Protection; Nokia Kirk Pond, former Chief Executive Officer; Fairchild Semiconductor Mike Ryan, Director, Study on Innovation, Expression and Development; Georgetown University Tim Trainer, President; Global Intellectual Property Strategy Center Xiaogang Wang, Associate; White & Case ©2005 Copyright PricewaterhouseCoopers. All Rights Reserved. Rights All PricewaterhouseCoopers. Copyright ©2005 I CONTENTS 1 Executive Summary 3 Key Findings and Recommendations 7 Introduction 9 China’s Influence on the IP Environment 39 Value Management Strategies 49 Complementary Conventional Approaches 63 Conclusion 65 End Notes LIST OF SIDEBARS 17 Research and Development in China 26 Public Good versus Private Interest in Chinese Antitrust Law 30 Outsider Perceptions of IP Rights Protection in China 36 A Differing View of Intangible Assets LIST OF TABLES 21 Overview of China’s Industrial Development Programs 42 Value Management Versus IP Protection-Centered Approaches 60 Information Loss Risks Related to Digital Business Files and E-Mail Redefining IP Value Management: The Case of China II LIST OF FIGURES 7 Percent of US Corporations’ Tangible and Intangible Asset Market Value 8 How China Affects the Global IP Landscape 8 Comparison of Value Management and Conventional IP Protection Methods 14 Imports of Big-Screen TVs and HDTVs from China, January 2000–September 2003 17 Government-Sponsored Research and Development by Category, China and the United States, 2002 and 2003 19 Average Daily Oil Demand, Top Five Countries, 2000–2004 39 Intangible Asset Management Scenarios in China 44 Evaluation of a Strategy that Focuses Only on IP Protection 53 Counterfeit Drug Cases Opened Annually by the US FDA, 1997–2004 55 Adoption Cycle of Anti-Counterfeiting RFID Systems in Pharmaceutical 61 Overview of How Document Control Systems Work 1 Executive Summary China’s new prominence as a manufacturing power has been beneficial to multinational companies seeking to leverage its low-cost labor force and seemingly unlimited capacity. Outsourcing low-value manufacturing operations to China enables corporations to pursue value chain specialization, in which they focus strategically on high-value activities such as marketing and research and development. As a result of this trend, China has come to dominate outsourced manufacturing, supplying as much as 50 to 80 percent of global production in many product categories. This circumstance has changed the way in which products are created. Even more importantly, it has transformed how they are valued. Certainly, low-cost manufac- turing has accelerated the devaluation of many product categories, yet this impact is only the most obvious one. China’s unique relationship with countless multinational companies (MNCs)—as both a global manufacturing partner and an emerging competitor—is altering established conventions about the definition, role, and protection of intellectual property (IP). The rapidly growing capabilities of Chinese manufacturers, com- bined with their rapid appropriation of IP (through both legal and illegal means) are having an unprecedented impact. The effect is transforming the structure of supply chains, the segmentation of value chains, and the relative value of the hard and soft constituents of products and services. Though the country’s influence on IP protection practices is undeniable, other fac- tors have also played a role, including the converging forces of the PC marketplace, distributed processing, new research and engineering technologies, and even the ability to raise vast amounts of capital on equity markets for relatively immature companies. Regulators, trade negotiators, and courts continue to struggle to define what can be protected and how protection is to be measured and enforced across a wide range of categories. The result is a turbulent, high-risk IP environment that may persist for the fore- seeable future. And it is not confined to only China; the country’s own global expansion initiative has forced the issue to become one of global importance. Thus, regardless of whether a company is doing business in China, it must adapt to these significant changes. Redefining IP Value Management: The Case of China 2 IP Value Management In order to successfully navigate this changing IP landscape, MNCs must rethink how they view, value, and protect their IP, the intangible assets that now represent IP value management is a as much as 85 percent of their corporate value. holistic approach to intellectual property rights, which re- At the heart of this new approach is a fundamental shift from merely protect- engineers core business ing IP through legal means to holistically cultivating and retaining value through strategies and operations to higher-level business strategies. This new approach, called IP value management, cultivate and preserve value moves a company’s IP activities from being primarily a legal function to becoming a in ways that are resistant to strategic imperative that is the domain of corporate leaders. IP value management the global and market forces focuses on reorienting and redesigning core business strategies and operations that have accelerated IP value to cultivate and preserve value in ways that are resistant to the global and market erosion. forces that have accelerated IP value erosion. Central corporate functions such as product and service design, marketing strategy and delivery systems, mergers and acquisition (M&A) objectives, and strategic alli- ances all play a role in optimizing and sustaining IP value. In fact, many established strategies used in each of these corporate functions has the potential to be refined IP protection is the as a component of a comprehensive IP value management strategy. conventional approach to intellectual property rights, For example, in the information technology industry, some software vendors have which is based upon the notion shifted to a product (and value management) strategy that defines attached ser- that IP value is embodied in the vices as the primary value component instead of core software products. Vendors legal recognition of ownership of enterprise resource planning, accounting, and tax software have found that of the product, processes, enhanced services coupled with standard product offerings will not only add rev- technologies, and know-how associated with an entity. This is enue, but anchor key product values and features. separate from the resources and competency to manufacture Scope of This Report that entity. IP protection centers This report examines in depth how the growth of the economy in China and its on maintaining that separation recent opening to international trade and finance is challenging conventional and providing the party with approaches to IP protection. It also details how the circumstances in China necessi- cognized IP ownership a tate that MNCs adopt a new IP value management approach to contend with these measure of economic value changes. Finally, it presents IP value management strategies for succeeding in this from the total value created in manufacturing the product. uncertain environment. 3 KEY FINDINGS AND RECOMMENDATIONS The following is a summary of the primary find- Tactical and legal, low-cost acquisitions of opera- ings. This report is based on third-party and origi- tions and facilities that include IP—from struggling nal research, including PricewaterhouseCoopers’ foreign companies or vertically integrated MNCs interviews with executives who have been involved who seek to shed their lower value manufacturing in or have been affected by intellectual property units entirely—are accelerating this movement. (IP) protection activities in China, particularly in Technology transfer has set China up to technology industries. become a global manufacturing and IP power- house. Ever since China opened its doors to for- KEY FINDINGS eign investment, the Chinese government has Chinese manufacturers are ultra lean and ultra consistently demanded technology transfer to its agile. They can move quickly to effectively become own manufacturing sector from foreign companies price and volume leaders in global manufacturing. that have a presence in the country. The goals of The challenges